Iran, Disaster Capitalism, and the Heritage Foundation (updated)

In September, I flagged a report from the Heritage Foundation on a wargame of an attack on Iran. It was intended to model less the military outcomes, and instead primarily the economic outcomes. They then attempt to simulate the effects of a variety of economic countermeasures that might be taken to mitigate some of the economic impact. Their choice of countermeasures, and their evaluation of their impact, is extremely interesting.

They did this through creation of an economic model of the international and US economy. They were supported by analysts at Global Insight (http://www.globalinsight.com/About/).

The report simulated a crisis occurring in January 2007, and lasting nine months. It led, in their worst-case scenario, to a loss of 6 million barrels per day. For context, the sum of Iran, Iraq, Saudi Arabia, Kuwait, and the UAE export 16 million barrels per day . So already, a question arises: this closing of the Straight leads to only a 35% loss of exports in the worst case? The Saudis, in a crisis, could export about 5 million barrels per day via pipeline to the Red Sea , but it's not clear how the other 5 million barrels are getting out.

Quoting from their report, they found that under worst-case circumstances:

• The price of West Texas Intermediate (WTI) crude[1] would peak in the third
  quarter of 2007 at $150 per barrel, an increase of $85 per barrel;

  Real (inflation-adjusted) gross domestic prod­uct (GDP) would fall by
  over $161 billion in the fourth quarter of 2007;

  Private non-farm employment would decline by over 1 million jobs by the
  middle of 2008; and

  Real disposable personal income would be more than $260 billion lower by the
  fourth quarter of 2007.

They then implemented their mitigation policies in the report, and found (quoted):The economics team ran new economic simulations based on these pol­icy responses and found that:

The price of WTI crude would peak in the first quarter of 2007 at $75 per
barrel, an increase of less than $12 per barrel;

Real GDP would remain at roughly non-crisis levels during 2007;

Employment would expand by 109,000 in 2007; and

Real disposable personal income would grow at non-crisis rates during 2007.

Wow, adding $260B to the US ecnonomy, and reducing the price of oil by $50 a barrel! That must be some big league economic prescriptions you've got at hand!

(I should say: already I'm annoyed. Apples to apples, please: what happens to employment by mid 2008 in the mitigated scenario? Also, numbers and percentages for everything, please.)

The results of the game also suggest that an offi­cial response to an actual crisis based on an Iran blockade of the strait might be effective. The experts who played the roles of the U.S. government offi­cials opted for a focused but restrained use of mili­tary power oriented toward objectives that directly addressed vital national interests and that were clear, relevant, and obtainable. This use of force demonstrated the U.S. determination to uphold freedom of navigation in the Strait of Hormuz. The American response did much to calm global markets and reassure American consumers.

All I can say to this is: well, it's your wargame. American consumers might be calmed (though this seems unlikely, see Lines, Gas, 1973). But I don't know what you have to smoke to think that global markets will be calmed by "use of force to uphold freedom of navigation in the Strait of Hormuz." In particular, I wonder what you have to smoke to think that any traffic at all will flow through it. That's not because Iranian power is so overwhelming. It's simply because of a much greater power: no insurance company on earth will insure the tankers as they pass through. And no COO is going to let those tankers out of port without insurance.

But moving on:

In addition, the experts chose to take a minimalist approach to interfering in U.S. domestic markets. They focused primarily on liberalizing domestic energy policies and rolling back regulatory restric­tions. They also strove to propose policy changes that would minimize fears over shortages beyond the immediate crisis.

Minimize fears over shortages? Again: see Lines, Gas, 1973.

So that's it? That's your big-league, $260 Billion-a-year plan? I'm afraid your slip is showing, Miss Heritage. Let's read that again:

In addition, the experts chose to take a minimalist approach to interfering in U.S. domestic markets. They focused primarily on liberalizing domestic energy policies and rolling back regulatory restric­tions.

This is what they're really after here.

Want to see their recommendations for mitigation?

• The U.S. and its allies deploy sufficient military forces to pro­tect freedom of navigation in the Strait of Hormuz. The partic­ipants assumed that the military response would be extensive, swift, and effective. They further assumed that the U.S. and allied military response to the blockade of the Strait of Hormuz would reduce Iran's obstruction of tanker traffic by 50 percent by January 31, 75 percent by March 31, and 100 percent by October 1, 2007.
• The U.S. government employ the Strategic Petroleum Reserve according to the rules laid out in international treaties.
• Congress pass a one-time emer­gency supplemental defense appropriation of $30 billion. Congress and the Administra­tion agree to increase funding for the Low-Income Home En­ergy Assistance Program.
• Congress and the Administration temporarily reduce regulatory burdens that would other­wise cause energy prices to increase.
• The U.S. government end tariffs on ethanol as of January 1, 2007.
• The Administration make no change in retail gasoline and diesel taxes.
• The Administration request permission to permit petroleum recovery in the Arctic National Wildlife Refuge (ANWR) and the off-shore reserves immediately west of Florida.
  

As I mentioned above, for the first point, it's demented to expect there will be any partial flow of uninsured supertankers through a warzone anytime in the first nine months of the crisis.

What else is there? Increased defense spending, release of the SPR, reduction of regulations, opening ANWAR, and no new fuel taxes. They later specify that the regulation they want to roll back is the Clean Air Act, CAFE standards, and the Jones Act.

The Heritage Foundation is a right-wing organization, a fact about which they make no bones. Opening ANWAR and destroying CAFE regulations are two long-time idees fixes of the right. Really, read these: in a time of oil crisis and shortage, the recommended response is to lower fuel efficiency and not to raise fuel taxes.

Neither ANWAR nor Florida could be brought online during this crisis. They cannot mitigate the crisis.

The SPR has about 57 days of supply, although in reality it can only be extracted at 1/3 the rate. About 4.4 million barrels per day could be extracted from it. Europe and Japan each have about 90 days of capacity. A nine-month crisis would more or less wipe out all the reserves, assuming that oil continues to flow from all other sources, and that Saudi Arabia pipes at full capacity to its Red Sea port.

In short: in such a crisis, roughly a quarter of the world's export capacity would come to a halt; the SPR's of the world would be drained; a single supplier--namely, Russia--would come to dominate exports. The Heritage Foundation wants you to believe that in this case, by symbolically opening ANWAR, by decreasing car fuel standards, by allowing increased pollution, and ending ethanol tariffs, the result will be to offset a doubling of oil prices and an economic slowdown.

Let's just sanity check that about oil prices, shall we?

Since January 2007, oil price per barrel has risen from $50 to $95. The additional production during this time has been well under 1%. So: no apparent increase in demand--and certainly none at the level of 90%. The dollar has fallen in value, but what is to say it would not fall even more dramatically in an oil crisis? Even measured in the dollar index basket of currencies, oil has risen from $50 to $80, by 60%. The most common reason given is that this is due to "geopolitical uncertainty", aka fear of attack on Iran.

The Heritage Foundation wants me to believe that fear of a disruption adds 60% to the price of a barrel of oil, but the actual disruption would only add 25%?

Numerical modeling of the sort that they undertake is often accurate only within a very limited regime around "normalcy". Google "mortgage payment model" and you'll get some idea how accurate trading models are outside of their original regime. The "black swan" events rarely result in happy normalcy.

Closing the Straits of Hormuz are surely not a minor fluctuation about normal, but instead a regime change. There's no reason to believe the models will work. Even the most simpleminded look at the numbers involved gives much reason to believe they will not.

But it's not really the point. Heritage wants to make sure they get CAFE repealed, Clean Air gutted, and ANWAR and the Gulf of Mexico opened.

"Disaster Capitalism" is Naomi Klein's term for a policy of deliberately planning to take advantage of crises and shocks to implement otherwise controversial policies. This is not to say that the crises and shocks are manufacured or conspiratorially arranged. It's merely to say, that some recognize that shocks are inevitable, and one might as well be ready to exploit them. (I've not read the book, and so won't sign on for claiming that every detail is something I agree with, but in the main it does accord with the cynical exploitation I felt like I saw happening post 9/11.)

It looks like we can see some of their planning ahead on display at the Heritage Foundation.

Update: I am also reminded of this little piece of disaster preparedness:

“We’re one bomb away from getting rid of that obnoxious [FISA] court,” Goldsmith recalls Addington telling him in February 2004.